INTRODUCTION TO

COST ACCOUNTING
• Cost Accounting may be defined as “Accounting for costs
classification and analysis of expenditure as will enable the
total cost of any particular unit of production to be ascertained
with reasonable degree of accuracy and at the same time to
disclose exactly how such total cost is constituted”.
• Costing : Costing is defined as the technique and process of
ascertaining costs
• Cost: Cost is a measurement, in monetary terms, of the
amount of resources used for the purpose of production of
goods or rendering services.
• Cost Accountancy is defined as ‘the application of Costing and
Cost Accounting principles, methods and techniques to the
science, art and practice of cost control and the
ascertainment of profitability’.
Cost Units
• It is a unit of product, service or time (or combination of these) in relation to
which costs may be ascertained or expressed.
• Cost units are usually the units of physical measurement like
➢number,
➢weight,
➢area,
➢volume,
➢length,
➢time and
➢value.
Cost Centres
• It is defined as a location, person or an item of equipment (or group of these) for
which cost may be ascertained and used for the purpose of Cost Control.
• Cost Centres are of two types,
• Personal Cost Centre: It consists of a person or group of persons e.g. Mr. X, supervisor,
foreman, accountant, engineer, process staffs, mining staffs, doctors etc.
• Impersonal Cost Centre: It consists of a location or an item of equipment (or group of
these) e.g. Ludhiana branch, boiler house, cooling tower, weighing machine, canteen,
and generator set etc.
• Cost Centre in a manufacturing concern: Two main types of Cost Centres are indicated
as below:
• Production Cost Centre: It is a cost centre where raw material is handled for conversion
into finished product. Here both direct and indirect expenses are incurred. Machine
shops, welding shops and assembly shops etc. are examples of production Cost Centres.
• Service Cost Centre: It is a cost centre which serves as an ancillary unit to a production
cost centre. Payroll processing department, HRD, Power house, gas production shop,
material service centres, plant maintenance centres etc. are examples of service cost
centres.
Cost Objects
• Cost object is anything for which a separate measurement of cost is required.
Cost object may be a product, a service, a project, a customer, a brand
category, an activity, a department or a programme etc.
Cost Drivers

• A Cost driver is a factor or variable which effect level of cost. Generally it is an

activity which is responsible for cost incurrence.
• Level of activity or volume of production is the example of a cost driver. An
activity may be an event, task, or unit of work etc.
• Examples of cost drivers are number of machines setting ups, number of
purchase orders, hours spent on product inspection, number of tests
performed etc.
 Objectives of Cost Accounting
• The following are the main objectives of Cost Accounting :-
• (a) To Ascertain the Costs under different situations using different techniques and
systems of costing
• (b) To determine the selling prices under different circumstances
• (c) To determine and control efficiency by setting standards for Materials, Labour and
Overheads
• (d) To determine the value of closing inventory for preparing financial statements of
the concern.
• (e) Assisting management in decision making: To provide a basis for operating
policies which may be determination of Cost Volume relationship, whether to close or
operate at a loss, whether to manufacture or buy from market, whether to continue
the existing method of production or to replace it by a more improved method of
production....etc
• (f) Cost Control and Cost Reduction
Cost Control Vs. Cost Reduction
Scope of Cost Accountancy
• The scope of Cost Accountancy is very wide and includes the following:-
• (a) Cost Ascertainment: The main objective of Cost Accounting is to find
out the Cost of product / services rendered with reasonable degree of
accuracy.
• (b) Cost Accounting: It is the process of Accounting for Cost which begins
with recording of expenditure and ends with preparation of statistical data.
• (c) Cost Control: It is the process of regulating the action so as to keep the
element of cost within the set parameters.
• (d) Cost Reports: This is the ultimate function of Cost Accounting. These
reports are primarily prepared for use by the management at different
levels. Cost reports helps in planning and control, performance appraisal
and managerial decision making.
• (e) Cost Audit: Cost Audit is the verification of correctness of Cost Accounts
and check on the adherence to the Cost Accounting plan. Its purpose is not
only to ensure the arithmetic accuracy of cost records but also to see the
principles and rules have been applied correctly.
 Advantages of Cost Accounting
• (i) A cost system reveals unprofitable activities, losses or inefficiencies occurring in any form such
as
• (a) Wastage of man power, idle time and lost time.
• (b) Wastage of material in the form of spoilage, excessive scrap etc., and
• (c) Wastage of resources, e.g. inadequate utilization of plant, machinery and other facilities.
• (ii) Cost Accounting locates the exact causes for decrease or increase in the profit or loss of the
business. It identifies the unprofitable products or product lines so that these may be eliminated
or alternative measures may be taken.
• (iii) Cost Accounts furnish suitable data and information to the management to serve as guides in
making decisions involving financial considerations.
• (iv) Cost Accounting is useful for price fixation purposes. Although sale price is generally related
more to economic conditions prevailing in the market than to cost, the latter serves as a guide to
test the adequacy of selling prices.
• (v) With the application of Standard Costing and Budgetary Control methods, the optimum level
of efficiency is set.
• (vi) Cost comparison helps in cost control.
 Advantages of Cost Accounting
• (vii) A cost system provides ready figures for use by the Government, wage
tribunals and boards, and labour and trade unions.
• (viii) When a concern is not working to full capacity due to various reasons such as
shortage of demands or bottlenecks in production, the cost of idle capacity can
readily worked out and repealed to the management.
• (ix) Introduction of a cost reduction programme combined with operations
research and value analysis techniques leads to economy.
• (x) Marginal Costing is employed for suggesting courses of action to be taken. It is
a useful tool for the management for making decisions.
• (xi) Determination of cost centres or responsibility centres to meet the needs of a
Cost Accounting system, ensures that the organizational structure of the concern
has been properly laid responsibility can be properly defined and fixed on
individuals.
 Limitations of Cost Accounting system
• Large number of Conventions, Estimates and Flexible factors: No
cost can be said to be exact as they incorporate a large number of
conventions, estimations and flexible factors such as :-
(i) Classification of costs into its elements.
(ii) Materials issue pricing based on average or standard costs.
(iii) Apportionment of overhead expenses and their allocation to cost
units/centres.
(iv) Arbitrary allocation of joint costs.
(v) Division of overheads into fixed and variable.
• Cost Accounting lacks the uniform procedures and formats in
preparing the cost information of a product/ service.
Financial Accounting and Cost Accounting:
Financial Accounting and Cost Accounting:
Classification of Costs
• It means the grouping of costs according to their common characteristics.
The important ways of classification of costs are:
• (1) By Nature or Element – Material, Labour, Other
• (2) By Functions/ Activities
• (3) by Relation to Cost Centre or Cost Unit
• (4) By Variability or Behaviour
• (5) By Controllability
• (6) By Normality
• (7)Time Period
• (8) By Costs for Managerial Decision Making
Direct Material Cost
• Direct material cost can be defined as ‘The Cost of material which can
be attributed to a cost object in an economically feasible way’.
• Direct materials are those materials which can be identified in the
product and can be conveniently measured and directly charged to
the product.
• The following are normally classified as direct materials :-
• (i) All raw materials, like jute in the manufacture of gunny bags, pig iron in
foundry and fruits in canning industry.
• (ii) Materials specifically purchased for a specific job, process or order, like
glue for book binding, starch powder for dressing yarn.
• (iii) Parts or components purchased or produced, like batteries for transistor-
radios.
• (iv) Primary packing materials like cartons, wrappings, card-board boxes, etc.
Indirect Material Cost
• Materials, the costs of which cannot be directly attributed to a
particular cost object. Indirect materials are those materials which do
not normally form a part of the finished product.
• It has been defined as “materials which cannot be allocated but
which can apportioned to or absorbed by cost centres or cost units”.
These are:
• (i) Stores used in maintenance of machinery, buildings, etc., like lubricants,
cotton waste, bricks and cements.
• (ii) Stores used by the service departments, i.e., non-productive departments
like Power House, Boiler House and Canteen, etc., and
• (iii) Materials which due to their cost being small, are not considered
worthwhile to be treated as direct materials.
Direct Labour / Employee Cost
• The cost of employees which can be attributed to a cost object in an
economically feasible way.
• In simple words, it is that labour which can be conveniently identified
or attributed wholly to a particular job, product or process or
expended in converting raw materials into finished goods. Wages of
such labour are known as direct wages.
Indirect Labour/ Employee Cost
• The labour / employee cost which cannot be directly
attributed to a particular cost object.
• The wages of that labour which cannot be allocated
but which can be apportioned to or absorbed by cost
centres or cost units is known as Indirect Labour.
Direct or Chargeable Expenses
• Direct expenses are expenses relating to
manufacture of a product or rendering a service
which can be identified or linked with the cost
object other than direct material cost and direct
employee cost.
Overhead
• Overheads comprise of indirect materials, indirect employee cost and
indirect expenses which are not directly identifiable or allocable to a
cost object.
• Overheads may defined as the aggregate of the cost of indirect
material, indirect labour and such other expenses including services
as cannot conveniently be charged directly to specific cost units.
• Thus overheads are all expenses other than direct expenses.
Classification by Functions:
Classification By Functions:
• Direct Material + Direct Labour + Direct Expenses = Prime Cost

• Indirect Material+ Indirect Labour + Indirect Expenses = Overheads

Classification by Relation to Cost Centre or Cost Unit:
By Controllability:
• Costs here may be classified into controllable and uncontrollable costs.
• (a) Controllable Costs: - Cost that can be controlled, typically by a cost, profit or
investment centre manager is called controllable cost. Controllable costs incurred
in a particular responsibility centre can be influenced by the action of the
executive heading that responsibility centre. For example, direct costs comprising
direct labour, direct material, direct expenses and some of the overheads are
generally controllable by the shop level management.
• (b) Uncontrollable Costs - Costs which cannot be influenced by the action of a
specified member of an undertaking are known as uncontrollable costs. For
example, expenditure incurred by, say, the tool room is controllable by the
foreman in-charge of that section but the share of the tool-room expenditure
which is apportioned to a machine shop is not to be controlled by the machine
shop foreman.
By Variability or Behaviour:
• According to this classification costs are classified into three group viz.,
1. fixed,

2. variable and

3. semi-variable.
By Normality:

According to this basis cost may be categorized as follows:

• (a) Normal Cost - It is the cost which is normally incurred at a given level of
output under the conditions in which that level of output is normally attained.
• (b) Abnormal Cost - It is the cost which is not normally incurred at a given level
of output in the conditions in which that level of output is normally attained.
Classification by Time:
 By Costs for Managerial Decision Making(1/4):
• (a) Pre-determined Cost - A cost which is computed in advance before production or
operations start, on the basis of specification of all the factors affecting cost, is known as a
pre-determined cost.
• (b) Standard Cost - A pre-determined cost, which is calculated from managements ‘expected
standard of efficient operation’ and the relevant necessary expenditure. It may be used as a
basis for price fixing and for cost control through variance analysis.
• (c) Marginal Cost - The amount at any given volume of output by which aggregate costs are
changed if the volume of output is increased or decreased by one unit.
• (d) Estimated Cost - Kohler defines estimated cost as “the expected cost of manufacture, or
acquisition, often in terms of a unit of product computed on the basis of information available
in advance of actual production or purchase”. Estimated costs are prospective costs since they
refer to prediction of costs.
• (e) Differential Cost - (Incremental and decremental costs). It represents the change (increase
or decrease) in total cost (variable as well as fixed) due to change in activity level, technology,
process or method of production, etc. For example if any change is proposed in the existing
level or in the existing method of production, the increase or decrease in total cost or in
specific elements of cost as a result of this decision will be known as incremental cost or
decremental cost.
 By Costs for Managerial Decision Making(2/4):
• (f) Imputed Costs - These costs are notional costs which do not involve any cash outlay.
Interest on capital, the payment for which is not actually made, is an example of imputed cost.
These costs are similar to opportunity costs.
• (g) Capitalised Costs - These are costs which are initially recorded as assets and subsequently
treated as expenses.
• (h) Product Costs - These are the costs which are associated with the purchase and sale of
goods (in the case of merchandise inventory). In the production scenario, such costs are
associated with the acquisition and conversion of materials and all other manufacturing inputs
into finished product for sale. Hence, under marginal costing, variable manufacturing costs
and under absorption costing, total manufacturing costs (variable and fixed) constitute
inventoriable or product costs.
• (i) Opportunity Cost - This cost refers to the value of sacrifice made or benefit of opportunity
foregone in accepting an alternative course of action. For example, a firm financing its
expansion plan by withdrawing money from its bank deposits. In such a case the loss of
interest on the bank deposit is the opportunity cost for carrying out the expansion plan.
• (j) Out-of-pocket Cost - It is that portion of total cost, which involves cash outflow. This cost
concept is a short-run concept and is used in decisions relating to fixation of selling price in
recession, make or buy, etc. Out–of–pocket costs can be avoided or saved if a particular
proposal under consideration is not accepted.
 By Costs for Managerial Decision Making(3/4):
• (k) Shut down Costs - Those costs, which continue to be, incurred even when a plant is
temporarily shutdown e.g. rent, rates, depreciation, etc. These costs cannot be
eliminated with the closure of the plant. In other words, all fixed costs, which cannot
be avoided during the temporary closure of a plant, will be known as shut down costs.
• (l) Sunk Costs - Historical costs incurred in the past are known as sunk costs. They play
no role in decision making in the current period. For example, in the case of a decision
relating to the replacement of a machine, the written down value of the existing
machine is a sunk cost and therefore, not considered.
• (m) Absolute Cost - These costs refer to the cost of any product, process or unit in its
totality. When costs are presented in a statement form, various cost components may
be shown in absolute amount or as a percentage of total cost or as per unit cost or all
together. Here the costs depicted in absolute amount may be called absolute costs and
are base costs on which further analysis and decisions are based.
• (n) Discretionary Costs – Such costs are not tied to a clear cause and effect relationship
between inputs and outputs. They usually arise from periodic decisions regarding the
maximum outlay to be incurred. Examples include advertising, public relations,
executive training etc.
 By Costs for Managerial Decision Making(4/4):
• (o) Period Costs - These are the costs, which are not assigned to the products
but are charged as expenses against the revenue of the period in which they are
incurred. All nonmanufacturing costs such as general & administrative expenses,
selling and distribution expenses are recognised as period costs.
• (p) Engineered Costs - These are costs that result specifically from a clear cause
and effect relationship between inputs and outputs. The relationship is usually
personally observable. Examples of inputs are direct material costs, direct labour
costs etc. Examples of output are cars, computers etc.
• (q) Explicit Costs - These costs are also known as out of pocket costs and refer to
costs involving immediate payment of cash. Salaries, wages, postage and
telegram, printing and stationery, interest on loan etc. are some examples of
explicit costs involving immediate cash payment.
• (r) Implicit Costs - These costs do not involve any immediate cash payment. They
are not recorded in the books of account. They are also known as economic
costs.
Valuation of Material
• Materials issued from stores should be priced at the value at which they are carried in
stock. But there can be a situation where the material may have been purchased at
different times and at different prices with varying discounts, taxes etc. Because of this
the problem arises as to how the material issues to production are to be valued.
• Several methods of pricing material issues have been evolved in an attempt to
satisfactorily answer the problem. These methods may be grouped and explained as
follows:

• Cost Price Methods: (a) Specific price method. (b) First-in First-out method. (c) Last-in-
First-out method. (d) Base stock method.
• Average Price Methods: (e) Simple average price method. (f) Weighted average price
method. (g) Periodic simple average price method. (h) Periodic weighted average price
method. (i) Moving simple average price method. (j) Moving weighted average price
method.
• Market Price Methods: (k) Replacement price method. (l) Realisable price method.
• Notional Price Methods: (m) Standard price method. (n) Inflated price methods. (o) Re-
use Price Method.
 Selection of Pricing Method
No hard and fast rule or procedure has been laid down to select a method of
pricing issues of material. However, the ultimate choice of a method of selection
may be based on the following considerations.
• (a) The method of costing used and the policy of management.
• (b) The frequency of purchases and issues.
• (c) The extent of price fluctuations.
• (d) The extent of work involved in recording, issuing and pricing materials.
• (e) Whether cost of materials used should reflect current or historical
conditions?
QUESTION (LIFO FIFO):
SOLUTION:
• 1. On 6-4-11, 250 units were issued to production. Under FIFO their value comes to Rs. 1,400
(100 units × ₹ 5 + 150 units × ₹ 6) and under LIFO ₹ 1,500 (250 × ₹ 6). Hence, ₹ 100 was more
charged to production under LIFO.
• 2. On 10-4-11, 400 units were issued to production. Under FIFO their value comes to ₹ 2,650
(150 × ₹ 6 + 250 × ₹ 7) and under LIFO ₹ 2,800 (400 × ₹ 7). Hence, ₹ 150 was more charged to
production under LIFO.
• 3. On 14-4-11, 500 units were issued to production. Under FIFO their value comes to ₹ 3,750
(250 × ₹ 7 + 250 × ₹ 8) and under LIFO ₹ 4,000 (500 × ₹ 8). Hence, ₹ 250 was more charged to
production under LIFO.
• Thus the total excess amount charged to production under LIFO comes to ₹ 500.
• The reasons for the difference of ₹ 500 (₹ 2,800 – ₹ 2,300) in the value of 350 units of Closing
Stock of material Exe under FIFO and LIFO are as follows :
• 1. In the case of FIFO, all the 350 units of the closing stock belongs to the purchase of material
made on 12-4-11, whereas under LIFO these units were from opening balance and purchases
made on 5-4-11, 8-4-11 and 12-4-11.
• 2. Due to different purchase price paid by the concern on different days of purchase, the value
of closing stock differed under FIFO and LIFO. Under FIFO 350 units of closing stock were
valued @ ₹ 8 p.u. Whereas under LIFO first 100 units were valued @ ₹ 5 p.u., next 50 units @
₹ 6 p.u., next 100 units @ ₹ 7 p.u. and last 100 units @ ₹ 8 p.u. Thus under FIFO, the value of
closing stock increased by ₹ 500.
 COST SHEET

• Cost sheet is defined by C1MA, U.K. as “a document which provides

for the assembly of the detailed cost of a cost centre or cost unit.”
• Thus cost sheet is a periodical statement of cost designed to show in
detail the various elements of cost of goods produced like prime cost,
factory cost of production and total cost.
• It is prepared at regular intervals, e.g., weekly, monthly, quarterly,
yearly, etc.
• Comparative figures of the previous period may also be shown in the
cost sheet so that assessment can be made about the progress of the
business.
Purposes
• Cost sheet serves the following purposes:
• 1. It reveals the total cost and cost per unit of goods produced.
• 2. It discloses the break-up of total cost into different elements of
cost.
• 3. It provides a comparative study of the cost of current period with
that of the corresponding previous period.
• 4. It acts as a guide to management in fixation of selling prices and
quotation of tenders.
Preparing Cost Sheet
• 1. Materials — Cost of materials includes cost of materials purchased
plus all expenses relating to purchases, e.g., carriage inward, octroi,
custom duty on imported materials, etc.
• 2. Labour — A distinction is to be made between direct labour and
indirect labour. Direct labour cost which is also known as productive
wages, is taken in the prime cost. Indirect labour cost or unproductive
wages are added in the factory overhead.
• 3. Overheads — Overheads are classified into three broad categories :
• (i) Factory Overhead.
• (ii) Office Overhead.
• (iii) Selling and Distribution Overhead.
SPECIMEN COST SHEET
Question:
Solution:
QUESTION:
QUESTION:
QUESTION:
THANK YOU!!!